Tuesday, August 03, 2010

The Proposed Bank of England Act - Part Five

Quantitative Easing has proven that the Bank of England can create money "out of nothing". This Bill proposes that instead of creating a small fraction of the national money supply out of nothing and then lending it largely to financial institutions, the Bank of England should create the entirety of the money supply, out of nothing and with careful regard to the monetary policy targets of the Treasury, and then give it, free of debt, to the government account. In order to prevent inflationary tendencies, this Act would ensure that the commercial banking system is prohibited from being able to use this money to multiply the amount of money in circulation through the lending process.

How much Money should be created by the Bank of England?

We know from the last twenty years that increasing the money supply by ten per cent a year leads to a financial crisis. It is envisaged that the exact level will be discovered through a period of trial and error, with small corrections, which will be no more severe than the current trial and error manipulation of interest rates that is undertaken by the Bank of England.

Will the Bank of England be able to create enough Money to meet the Needs of Borrowers?

The Monetary Policy Committee will be able to judge how long it will take the money it creates to circulate to lending institutions. The Committee will then adjust the amount it creates accordingly. The Committee cannot do worse in this respect than commercial bankers who created far too much money in the boom and are now creating far too little in the bust.

Will this lead to Higher Bank Costs?

Losing the subsidy they now enjoy from being allowed to create money to lend may lead existing commercial banks to charge more for managing the payments systems they offer to their customers. That is always likely to be the immediate response of any industry that stops being subsidised. In the longer run, their charges are likely to be under fiercer competition from new entrants into the payments services industry. Moreover, their customers will no longer be bearing the costs imposed on every user of money when almost all the money in circulation has been created as interest-bearing debt. Among other things, their revenues will be based on customer account transaction service charges, management fees for operating pooled savings and loan and investment funds, profits from brokerage and trading in non-money financial instruments, professional fees for raising capital, and managing complex financial transactions.

What stops the Government abusing the Money Creation Process for its own Ends?

This Act would separate the creation of money from the executive and legislative powers. Section 5 ensures that the Monetary Policy Committee will be independently responsible for deciding how much new money should be created, and will create it, with no interference from government, in accordance with the monetary policy objectives which have been democratically approved. The Committee will not be "creating as much money as the government needs to fulfil its election manifesto". It is prohibited from considering the needs of the government of the day by section 5(2)(a). The Committee shall follow the general principle that it is the financial needs of the economy which must be addressed and calculated, not the political needs of the government. Section 6 ensures that the Committee will be subject to democratic oversight and scrutiny.

How will this affect the increasing National Debt?

The national debt is projected to hit around GBP 1,406 billion by 2014/15. That is GBP 57,000 per annum for every British household or GBP 23,433 for every man, woman and child in Britain. At present, this debt must be paid from taxation, selling national assets, or borrowing even more. This is becoming unsustainable.

The proposal in this Bill would enable the UK's national deficit - the amount we need to borrow each year - to fall. It would also allow the national debt to be paid down over time. Ultimately the decision on how to use the money which has been created by the Monetary Policy Committee will be the decision of the elected government. However, without this proposal, it is difficult to see how the burgeoning national debt can be managed in a sustainable manner.

Will this prevent Britain having to go to the IMF for a Loan?

Yes. It will enable Britain to create its own money supply directly and free of debt, instead of having to borrow debt from someone, or something, else.

Will this affect the "Glass-Steagall" Proposals to separate Retail and Investment Banking?

It has been suggested by various commentators that banks should be prohibited from exposing the taxpayer to massive losses by using their customers' funds to make risky trades in financial markets. Under the current system, by depositing money into a bank account, a customer effectively gives the bank 'carte blanche' to do what it pleases with that money, whether it is investing it in mortgages to wealth-solvent families, or mortgages to low-income households with little ability to repay, or taking huge risks in financial markets. If the banks are successful in their investments, they keep the profits. If they fail, as they did in 2007, then taxpayers suffer the financial losses.

This Act would ensure that taxpayers and the government have absolutely no exposure to losses made by the banks because it separates Secure Customer Transaction Accounts from Customer Investment Accounts. The money in Secure Customer Transaction Accounts is not available for any kind of investment activity and therefore remains 100% protected. Only those monies in Customer Investment Accounts would be available for investment, and any associated consequent risk and possible loss. This separation alone solves the problem of banks gambling with all customer deposits without any requirement to implement a "new Glass-Steagall Act".

How will this affect Bankers' Bonuses?

Bankers' bonuses are only as large as they are because the profitability of the banking sector is artificially inflated. Without the privilege of creating 97% of the nation's money supply and collecting the interest charges on that amount, the banking sector would only be as profitable as other industries. In high-street banking in particular, staff selling products such as mortgages and credit cards will be rewarded not for pushing as much debt onto the public as possible, but for finding good quality, reliable borrowers who can afford to borrow. This is not specified in the Bill, but is a natural consequence of the changes which the Act would deliver. When the total amount of funds for lending is limited, and each loan made does not create an equal amount of new deposits, as happens under the current system, then banks will shift their focus to finding good quality borrowers and productive investments, rather than simply issuing as much debt as possible to people with no ability to repay.

Moreover, a large proportion of bonuses are paid to those working in investment banking - often helping large corporations take over or merge with other corporations. These takeovers and mergers often saddle the firms involved with huge debts, and in the long term actually harm, rather than help, both the buying company and the company being bought. After the reform, investment will be limited to the amount of money that people, in total, wish to save. The total number of mergers and corporate takeovers may be reduced, and only those takeovers that really do benefit both companies will be able to go ahead. Consequently, this sector of the finance industry will no longer turn over so much revenue, and as a result, the huge bonuses seen over the last few years will no longer be justifiable.

Some may argue that reducing the profits of the banking sector will lead to a loss of tax revenue. However, the profits of the banking sector are won at the expense of the people of the UK, through inflated house prices, taxes to fund the national debt, and a tax burden which is thirty per cent higher than it would be if the proceeds of money creation accrued to the state instead of the commercial banking sector.

How will this affect the "Robin Hood" or "Tobin Tax"?

This Bill intends to prevent money being created by banks. It brings the money creation power under public control. This would generate more income than a tax on currency transactions. A Tobin Tax may reduce volatility and "churning" - frequent trading of stocks in order to earn extra commissions - in financial markets.

Will this Proposal Lead to Inflation?

The total amount of money in the UK has already been growing by an average of 11.7% a year for the last forty years (an eighty-fold increase over four decades). This new money is money that has been created by the commercial banks, which is matched by the exact same amount of debt. This 11.7% year-on-year growth in the money supply has led to a 36-fold increase in the national debt (See Treasury figures) and a 47-fold increase in house prices (See the Nationwide House Price Index) during that time, and inflation - if property prices are included - likely to be far beyond the official figures published by the government. That is to say, commercial bank lending and commercial bank money-creation already creates considerable inflation. It is a premise of this draft Bill that exclusive control of the money supply by the Bank of England, and a prohibition upon commercial banks of creating new money, would reduce and stabilise inflationary pressures in the economy.